Locomotive leasing-really! - 2002 Guide to Equipment Leasing - Brief Article

Railway Age, June, 2002

What's crazy about leasing SD40-2 locomotives that are worth between $175,000 and $200,000 to railroad operators for between $125 and $150 per day? Start with the fact that 12 months ago the same locos were worth between $275,000 and $325,000. Even crazier might be the fact that some lessors did the "right" thing with respect to the units in which they had invested and had them rebuilt, raising the investment to between $600,000 and $900,000 plus. Now it is true that these rebuilt units--given their reliability--are commanding $100 or more additionally in daily rental. The problem from a lessor's perspective would likely be that the daily rental assumed when these units were rebuilt was probably somewhere between $275 and $325 per day. Anyway you cut it, lessors are coming up short.

What's happened? The intense competition that defines the new, high horsepower, six-axle locomotive marketplace has caused the new locomotive manufacturers--the OEMs (original equipment manufacturers)--to arrange financing for brand new units at less than the $275 to $325 that some lessors had been expecting for their rebuilt SD40-2s. True, the financing is long term, as long as 20 years in some cases, but, then again, so is the need of Glass I railroads for efficient, long lived, reliable power.

But, the big question is what happens next? This depression in second-generation high horsepower locomotive values is only about two years old. It started when Union Pacific began taking delivery of 1,000 new EMD SD70M locomotives on a three year contract, complete with short, medium, or long term lease financing, provided by General Motors. UP's stated goal in acquiring these units was to homogenize and upgrade its fleet. One of the results of this fleet overhaul--other than increased efficiency and reliability--was a veritable flood of first and second generation diesel-electric locomotives on the secondary market. Given that these units hit the market when overall demand for used locomotives was down due to economic conditions and the emerging efficiencies of newly merged Class I's, prices dropped like a stone. Lease pricing soon followed.

As we have reported in the past, we think many of these used, worn-out locomotives will be parted-out. Their "running-takeout" components have significant and continuing value as replacements in the nation's existing locomotive fleet. At some point, the balance will be scrapped. In the meantime, the nation's handful of locomotive lessors are left to ponder the future of a fleet of locomotives that, like their railcar cousins, may be worth decidedly less than their book values.

Disaster? Perhaps not. The word from the locomotive leasing trenches is that the demand for short term leases of all types of reliable, used high-horsepower locomotives is picking up. Credit Class I predictions of increased traffic during the balance of 2002 and into 2003. It appears that no one wants to herald the return of traffic with the cry, "But we're short of power!"

What about the new stuff? For those readers who seek to provide long term finance leases on new locomotives, we'd suggest a listen to the folks at UP who are heralding the benefits attendant on a newly homogenized, reliable line-haul locomotive fleet. We still predict that both of the OEMs will find ways to continue to build ever more cost efficient new locomotives for service at the Class I's and find ways to finance them.

What about the low horsepower units? The GP38s and GP38 wannabes? The GP9s? The GP10s? And their "-2" cousins, the GP38-2s and the SD38-2s? What about the socalled GP38-3 locomotives with their retrofitted microprocessors? What about the leasing market for these medium horsepower units?

As we've said in our "Financial Edge" column over the years, as long as the powers that be continue to mint new short line railroads there will be new homes for low horsepower (SWl200 and SW1500 locomotives and their earlier cousins) and medium horsepower GP38-rype power. LLP, the joint venture formed a number of years ago by EMD and GATX Capital, is a specialist in such power and appears bullish for the future of this type of unit. It's still investing in them. Add to this demand the likelihood that industries served by Class I's seeking to offload switching duties will continue to be candidates for net and full service leases of both SW and GP-type power and the demand picture for such rented units continues to be bright.